Super or the mortgage?

Most of us wait until the mortgage is paid off before making larger “catch-up” contributions to superannuation but the recent halving of the annual concessional cap makes this harder to do.

So, you should consider making additional contributions earlier.

On July 1, last year, the concessional cap was cut from $50,000 to $25,000 per year for people aged 50 or over. The cap includes compulsory Superannuation Guarantee (SG) contributions made by your employer, pre-tax (salary sacrifice) contributions made by you and personal contributions claimed as a tax deduction. They are ‘concessional’ because they’re taxed at 15%, not your marginal tax rate.

What this means for you

If you wait until you’re debt free before topping up your super you may find you’re restricted by the annual cap.

So, MLC’s technical experts say if you can afford to make more than minimum home loan repayments, then you could have a higher super balance at retirement by using that money to make additional super contributions instead.

You’ll take longer to pay off your loan. But, you can take greater advantage of your annual concessional cap by spreading it over more years of your working life.  

Tax and cashflow advantages

While home loan repayments are usually made with after-tax money, super contributions can be:

• made with pre-tax dollars through salary sacrifice, or

• claimed as a tax deduction.

For example, if you salary sacrificed $1,000 in pre-tax income into super, you would invest a net $850, after 15% tax is deducted.

On the other hand, if you received the same amount of pre-tax money as after-tax salary and you pay tax at a marginal rate of say 38.5% (including 1.5% Medicare), you would only have $615 available for mortgage repayments.

Therefore, you would invest $235 more in super than you would pay off your mortgage. The table below shows the tax implications in both scenarios.

Case study

Max is 45 and earns $100,000 a year plus 9% SG contributions from his employer, and wants to retire at 60.

He owns a home worth $700,000 and owes $300,000 on his mortgage. The remaining term is 15 years and the minimum repayment is $2,867 per month. He’s considering the following two options:

1. Make minimum home loan repayments and top-up his employer’s SG contributions so he takes full advantage of the concessional contribution cap in each of the next 15 years.

This means he:

• Won’t pay off his home loan until he’s 60.

• Will maximise his concessional contributions over the next 15 years.

MLC estimates he’ll add an extra $740,8381 to his super, including future SG contributions if he uses this strategy.

1. Use the cashflow he would use topping up his employer’s SG contributions in option 1 above to make extra mortgage repayments. Then when he is debt-free he’ll top-up his SG contributions to take full advantage of the annual concessional cap and use any money left to make non-concessional (after-tax) contributions.

This means he:

• Will pay off his mortgage in an estimated 9 years and 3 months.

• Will only maximise his concessional contribution cap for 5 years

  and 9 months.

MLC estimates Max will accumulate an extra $659,860¹ in super, including future SG contributions.

By using option 1, Max could retire with his mortgage paid off and an extra $80,979 in super.

Assumptions: Home loan interest rate is 8% pa. Total pre-tax investment return is 7.7% pa (split 3.3% income and 4.4% growth). Investment income is franked at 30%. Salary is not indexed. SG contributions are increased progressively to 12% by 2019/20 as legislated. CC cap is increased by $5,000 in 2014/15, 2019/20 and 2024/25. Earnings in super are taxed at 15%. No allowance has been made for CGT that would be payable if investments were redeemed.

1 These figures ignore Max’s existing super balance.

Things to consider

• Access: While making extra super contributions could help you retire with more super, it’s important to consider if you’ll need any of the money before retirement.

A key benefit of extra home loan repayments is they can usually be accessed through a redraw facility.

• Your age: If you’re 55 and intend to keep working, starting a Transition to Retirement (TTR) pension and using the income to target your concessional cap may be better.
  
  Call us on 07 3281 1226 to find out if this approach will work for you.

• Investment risk: You may need to take a moderate degree of investment risk to do this. By comparison, paying more off your mortgage is risk-free.